How to split equity in a startup
Successful entrepreneurs advise startuppers to be very specific about their future and have all agreements settled beforehand.
Starting up your own tech business is thrilling and challenging. It teaches you many practical skills like entrepreneurship, leadership, and responsibility. Along the bumpy entrepreneurial path, equity allocation is one of the first serious decisions startuppers make. Apart from financial and legal competences, this task also requires analytical skills and a deep sense of justice. This article will help you out with startup equity, providing several possible patterns of its allocation.
Things for consideration
Before getting the ball rolling, one needs to understand that equity allocation is the distribution of one’s ownership in a company among its founders. The right to participate in decision-making becomes legit, which in turn brings more trust and dedication to the work process.
There are many factors that are paramount to the successful and (what is more important) fair equity allocation. Take the following 5 points as basics and discuss them with your co-founders to find common ground.
When you start looking for funds, keep in mind that investors will ask for nearly 30% of your company’s shares. If initially you distributed the equity 20/80, this ratio would dilute to 14/56 respectively. The situation with one co-founder owning less than investors may be dismaying, so take it into account straight away.
- Key employees
Not only co-founders but also key employees are worth considering for equity shares. As your company scales up, there will bemore decision-makers. Consequently, in order to retain the most committed people you’ll need to offer something more valuable (like employee stock options). Very often private companies offer their employees to buy 10% of shares in the company’s stock. For your offshore development teams, the stock option plan is also applicable.
To arrange this process, consult local firms that specialize in tech. For example, at Alcor we provide stock option plans and other legal services for IT companies in Ukraine. As a service provider, we mainly support all back-office operations like HR payroll, recruitment, accounting, office searches, procurements, or legal compliance, etc. All of this to make sure startups, SMEs, and giant tech companies from other countries feel comfortable in Ukraine.
- Expertise and risks
The more expertise and commitment co-founders bring, the more equity they deserve. Looking at theirprevious work experience and risks they are now taking, you can decide on the type of involvement and amount of shares accordingly.
- Money invested
Coming back to materialistic contributions, it’s necessary to accept that bootstrapping is also a kind of investment. Money brought by co-founders needs to be backed up by an asset. A part of the equity is their reward and motivation for further hard work.
- Vesting schedule
Startup advisors recommend putting co-founders on a vesting schedule. This system implies that their part of shares will be gradually vested after a certain period of time (usually over several years). In this way, startuppers secure their business and test the partners.
How to divide equity in a startup
When thinking abouthow to divide equity startup founders, advisors, and employees, one of the core issues lies in the number of shareholders. Considering 10% for your key employees as part of your company’s stock option plan, you also need to leave up to 30% of equity shares for venture and angel investors.
The next important step is to distribute shares among co-founders in the right proportion. At its most basic, equity can be allocated between 2 or 3 co-founders. If there are two of you, do not resort to a 50/50 split. Such practice sends signals about irresponsibility to the team, because no one person is ready to take the lead.
Likewise, to divide equity among three co-founders into 33/33/33 will produce the same effect. Basically, the best equity split for two or three co-founders in a startup is around 45/50 and 30/30/40 since it highlights the chief decision-maker and no one feels underestimated.
Successful entrepreneurs advise startuppers to be very specific about their future and have all agreements settled beforehand. While allocating company equity, it’s difficult to judge material and non-material contributions of co-founders together. Therefore, just think carefully about the overall input each of them is bringing to the table.
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